credit

Business Insider reports on a Bloomberg TV interview with hedge fund legend Stan Druckenmiller that helped crystallize in my mind what, exactly, I find so appalling about people who say that we must tighten monetary policy to avoid bubbles — even in the face of high unemployment and low inflation.

Druckenmiller blames Alan Greenspan’s loose-money policies for the whole disaster; that’s a highly dubious proposition, in fact rejected by all the serious studies I’ve seen. (Remember, the ECB was much less expansionary, but Europe had just as big a housing bubble; I vote for Minsky’s notion that financial systems run amok when people forget about risk, not because central bankers are a bit too liberal)

Krugman correctly identifies the mechanism here — prior to 2008, people forgot about risk. But why did people forget about risk, if not for the Greenspan put? Central bankers were perfectly happy to take credit for the prolonged growth and stability while the good times lasted.

Greenspan put the pedal to the metal each time the US hit a recession and flooded markets with liquidity. He was prepared to create bubbles to replace old bubbles, just as Krugman’s friend Paul McCulley once put it. Bernanke called it the Great Moderation; that through monetary policy, the Fed had effectively smoothed the business cycle to the extent that the old days of boom and bust were gone. It was boom and boom and boom.

So, people forgot about risk. Macroeconomic stability bred complacency. And the longer the perceived good times last, the more fragile the economy becomes, as more and more risky behaviour becomes the norm.

Stability is destabilising. The Great Moderation was intimately connected to markets becoming forgetful of risk. And bubbles formed. Not just housing, not just stocks. The truly unsustainable bubble underlying all the others was debt. This is the Federal Funds rate — rate cuts were Greenspan’s main tool — versus total debt as a percentage of GDP:

In endorsing Minsky’s view, Krugman is coming closer to the truth. But he is still one crucial step away. If stability is destabilising, we must embrace the business cycle. Smaller cyclical booms, and smaller cyclical busts. Not boom, boom, boom and then a grand mal seizure.

“Debt,” says Graeber, “is how the rich extract wealth from the rest of us.” But sometimes he seems to claim that creditors are extracting wealth from debtors, and sometimes he seems to claim that debtors extract wealth from creditors.

For example, in the Nation article, Graeber tells that The 1% are creditors. We, the people, have had our wealth extracted from us by the lenders. But in his book, Graeber writes that empires extract tribute from less powerful nations by forcing them to lend the empires money. In the last chapter of Debt, Graeber gives the example of the U.S. and China, and claims that the vast sums owed to China by America are, in fact, China’s wealth being extracted as tribute. And in this Businessweek article, Graeber explains that “throughout history, debt has served as a way for states to control their subjects and extract resources from them (usually to finance wars).”

But in both of these latter cases, the “extractor” is the debtor, not the creditor. Governments do not lend to finance wars; they borrow. And the U.S. does not lend to China; we borrow.

So is debt a means by which creditors extract wealth from debtors? Or a means by which debtors extract wealth from creditors? (Can it be both? Does it depend? If so, what does it depend on? How do we look at a debtor-creditor-relationship and decide who extracted wealth from whom?) Graeber seems to view the debtor/creditor relationship as clearly, obviously skewed toward the lender in some sentences, and then clearly, obviously skewed toward the borrower in other sentences.

But these can’t both be clear and obvious.

What Graeber means by “extracting wealth” in the context of a relationship between, say a mortgager and a mortgagee seems to mean the net transfer of interest. It is certainly true on the surface that there is a transfer of wealth from the debtor to the creditor (or from the creditor to the debtor if the debtor defaults).

However, between nations Graeber sees the relationship reversed — that China is being heavily and forcefully encouraged to reinvest its newly-amassed wealth in American debt (something that some Chinese government sources have suggested to be true). But if the flow of interest payments — i.e. from America to China — is the same debtor-to-creditor direction as between any creditor and debtor, then is the relationship really reversed? If China is being forced to amass American debt by the American government, is America effectively forcing China into “extracting its wealth”?

The thing Graeber seems to miss is that the transfer of interest is the payment for a service. That is, the money upfront, with the risk of non-repayment, the risk that the borrower will run off with the money. That risk has existed for eternity. In this context, the debtor-creditor relationship is a double-edged sword. Potentially, a debtor-creditor relationship could be a vehicle for both parties to get something that benefits them — in the case of the debtor, access to capital, and in the case of the creditor, a return on capital.

In the case of China and America, America may choose to pay off the debt in massively devalued currency, or repudiate the debt outright. That’s the risk China takes for the interest payments. (And the counter-risk of course being that if America chooses to repudiate its debt, it risks a war, which could be called the interstate equivalent of debtors’ prison).

But what if tensions over debt lead to conflict? It would be foolish to rule out those kinds of possibilities, given the superficial similarities in the relationship between China-America and that of Britain-Germany prior to World War I. It is more than possible for an international creditor-debtor relationship to lead to conflict, perhaps beginning with a trade war, and escalating — in fact, it has happened multiple times in history.

It is certainly true that devious creditors and debtors can extract wealth from each other, but so can any devious economic agent — used car salesmen, stockbrokers, etc. The actual danger of creditor-debtor relationships, is not so much wealth extraction as it is conflict arising from the competition inherent to a creditor-debtor relationship. Creditors want their pound of flesh plus interest. Debtors often prefer to be able to shirk their debts, and monetary sovereign debtors have the ability to subtly shirk their debts via the printing press. That is potentially a recipe for instability and conflict.

There is also the problem of counter-party risk. The more interconnected different parties become financially, the greater the systemic risks from a default. As we saw in 2008 following the breakdown of Lehman Brothers, systemic interconnectivity can potentially lead to default cascades. In that case, debt can be seen as a mutual incendiary device.

So the debtor-creditor relationship is very much a double-edged sword. On the one hand, if all parties act honestly and responsibly debt can be beneficial, allowing debtors access to capital, and allowing creditors a return on capital — a mutual benefit. In the real world things are often a lot messier than that.

Interconnected networks exhibit a knife-edge, or tipping point, property. Within a certain range, connections serve as a shock-absorber. The system acts as a mutual insurance device with disturbances dispersed and dissipated. But beyond a certain range, the system can tip the wrong side of the knife-edge. Interconnections serve as shock-ampliers, not dampeners, as losses cascade.The system acts not as a mutual insurance device but as a mutual incendiary device.

The data (released by BP a company who have a vested interest in oil scarcity) don’t agree. Proved reserves keep increasing:

The oil in the ground will run out some day. But as the discovery of proven reserves continues to significantly outpace the rate of extraction, the claims that we’re facing immediate shortages looks trashy.

Some may try to cast doubt on these figures, saying that BP are counting inaccessible reserves, and that we must accept that while there are huge quantities of shale oil in the ground, the era of cheap and readily accessible oil is over. They might cite the idea that oil prices are much higher than they were ten years ago. Yet this is mostly a monetary phenomenon resulting from excessive money creation beyond the economy’s productive capacity. Priced in gold, oil is still very cheap — almost as cheap as it has ever been:

The argument that the vast majority of counted reserves are economically inaccessible is fundamentally flawed. In the long run there is only one equation that really matters in determining whether oil is extractable, and that is whether there is a net energy gain; whether energy-in exceeds energy-out. If there’s a net energy gain, it’s feasible. Certainly, we are moving toward a higher cost of energy extraction. Shale oil (for example) has a lower net energy gain than conventional oil, but still typically produces five times as much energy as is consumed in extraction.

But the Earth’s extractable hydrocarbons will eventually dry up, whether that’s in 500 years or 200 years. If we want humanity to have a long-term future on Earth, we need to move to renewables; solar, hydroelectric, thorium, synthetic hydrocarbons. And the market will ensure that, eventually — as the cost of renewable energy continues to fall, more and more of us will adopt it. I don’t buy the myth that markets are stupid — if humanity needs renewable energy (I believe we do) the market will see to it (I believe that is slowly happening). Markets are just the sum of human preferences.

Power from renewable energy sources is getting cheaper every year, according to a study released Wednesday, challenging long-standing myths that clean energy technology is too expensive to adopt. The costs associated with extracting power from solar panels has fallen as much as 60 percent in just the past few years.The price of generating power from other renewables, including wind, hydro power, concentrating solar power and biomass, was also falling.

So no. I’m not lying awake at night worrying about imminent peak oil. There’s plenty of extractable oil, and renewable energy will eventually supplement and replace it. But will politics get in the way of energy extraction? The United States has huge hydrocarbon reserves, yet regulation is preventing drilling and shipment, leaving America dependent on foreign oil. And the oil companies themselves are largely to blame — after Deepwater Horizon, should anyone be surprised that politicians and the public want to strangle the oil industry?

If there’s an imminent energy crisis, it will be man-made. It will come out of the United States’ dependency on foreign oil. Or out of an environmental catastrophe caused by mismanagement and graft (protected cartels like the energy industry always lead to mismanagement). Or out of excessive red tape. Or war.

These figures are staggering; the advanced nations typically have between three and ten times as much total debt as they have economic activity. In the United Kingdom — the worst example — if one year’s economic activity was devoted entirely to paying down debt (impossible — people need to eat and drink and pay rent, and of course the United Kingdom continues to add debt) it would take ten years for the debt to be wiped clean.

But the real question is why? Why are both debtors and creditors willing to build a status quo of massive unprecedented debt?

From the side of the creditors, I think the answer is the misconception that debt is wealth. Debt can be used as collateral, or can be securitised and traded on exchanges (which itself can become a form of shadow intermediation, allowing for a form banking outside the accepted regulatory norms). To keep the value of debt high, and thus keep the debt illusion rolling along (treasury yields keep falling) central banks have been willing to swap out bad debt for good money. But debt is not wealth; it is just a promise, and in today’s world carries huge counter-party risk. Until you convert your debt-based promissory assets into real-world tangible assets they are not wealth.

From the side of the debtors, I think the answer is that debt is easy. Why work for your consumption when instead you can take out a home equity loan or get a credit card? Why buy the one car that you can afford when instead you can buy two with debt?

But there is another side in this world: the side of the central planners. Since the time of Keynes and Fisher there has been an economic revolution:

Deflation has effectively been abolished by central banking. And so we get to where we are today: the huge and historically unprecedented outgrowth of debt. Deleveraging necessitates economic contraction, which produces the old Keynesian-Fisherian bugbear of debt-deflation, which the central planners abhor. So they print. Where once deflation often made debts unrepayable, and resulted in mass defaults, liquidation and structural transformation, today — thanks to money printing — debtors get their easy lunch of cheap debt, and creditors get their pound of flesh, albeit devalued by the inflation of the monetary base. It has been a superficially good compromise for both creditors and debtors. Everyone has got some of what they want. But is it sustainable?

The endless post-Keynesian outgrowth of debt suggests not. In fact, what is ultimately suggested is that the abolition of small-scale deflationary liquidations has just primed the system for a much, much larger liquidation later on. Bad companies, business models and practices that might otherwise not have survived under previous economic systems today live thanks to bailouts and money-printing. This moral hazard has grown legs and evolved into a kind of systemic hazard. Unhealthy levels of leverage and interconnection that once might have necessitated failure (e.g. Martingale trading strategies) flourish today under this new regime and its role as counter-party-of-last-resort. With every rogue-trader, every derivatives or shadow banking blowup, every Corzine, every Adoboli, every Iksil, comes more confirmation that the entire financial system is being zombified as foolish and dangerous practices are saved and sanctified by bailouts.

With every zombie blowup comes the necessity of more money-printing, and with more money-printing to save broken industries seems to come more moral hazard and zombification. Is that sustainable?

Already, central bankers are having to be clever with their money printing, colluding with financiers and sovereign governments to hide newly-printed money in excess reserves and FX reserves, and colluding with government statisticians to hide inflation beneath a forest of statistical manipulation. It is no surprise that by the BLS’ previous inflation-measuring methodology inflation is running at a much higher rate than the new:

Worse, in the modern financial world, we see an unprecedented level of interconnection. The impending Euro-implosion will have ramifications to everyone with exposure to it, and everyone with exposure to those with exposure to it. Not only will the inflation-averse Europeans have to print up a huge quantity of new money to bail out their financial system (the European financial system is roughly three times the size of the American one bailed out in 2008), but should they fail to do so central banks around the globe will have to print huge quantities of money to bail out systemically-important financial institutions with exposure to falling masonry. This is shaping up to be a true test of their prowess in hiding monetary inflation, and a true test of the “wisdom” behind endless-monetary-growth fiat economics.

Central bankers have shirked the historical growth cycle consisting both of periods of growth and expansion, as well as periods of contraction and liquidation. They have certainly had a good run. Those warning of impending hyperinflation following 2008 were proven wrong; deflationary forces offset the inflationary impact of bailouts and monetary expansion, even as food prices hit records, and revolutions spread throughout emerging markets. And Japan — the prototypical unliquidated zombie economy — has been stuck in a depressive rut for most of the last twenty years. These interventions, it seems, have pernicious negative side-effects.

Those twin delusions central bankers have sought to cater to — for creditors, that debt is wealth and should never be liquidated, and for debtors that debt is an easy or free lunch — have been smashed by the juggernaut of history many times before. While we cannot know exactly when, or exactly how — and in spite of the best efforts of central bankers — I think they will soon be smashed again.

A huge mountain of interlocking, interconnected debt is a house of cards, and a monetary or financial system based upon such a thing is prone to collapse by default-cascade: one weak link in the chain breaks down the entire system.

But the next collapse of the debt-pyramid is a long-term trend that may be a long way — and a whole host of bailouts — away yet. A related but different problem is that of government spending. Here’s American government debt-to-GDP since the end of WW2:

After reducing the national debt to below 40% in the 70s and 80s America’s credit binges since that era have quickly piled on and on to the point that without a major war like World War 2, the national debt is above 100% of GDP, and therefore in a similar region to that period.

Simply, America’s government must find a way not only of balancing the budget, but of producing enough revenue to pay down the debt. This has inspired the current crop of Republican nominees to produce a slew of deficit-reduction plans, including Herman Cain’s hole-ridden9-9-9 plan which shifts a significant burden of taxation from the wealthy and onto the middle classes. Worse still, taxes on spending hurt the economy by discouraging spending. Want to expand your business with the purchase of new capital goods? 9% tax. Want to increase revenues through advertising? 9% tax. Want to spend your earnings on goods? 9% tax. That’s a hardly a policy that will encourage economic activity in an economy that is (for better or worse) led by consumption.

Whichever way the tax burden falls, the sad reality is that any plan that focuses on taxing-more-than-disbursing is just sucking productive capital out of the economy, constraining growth. The other “remedy” inflating the currency (to inflate away the debt), punishes savers, whose investment is necessary for productive growth.

All the crushing weight of taking productive capital out of the economy crushed growth. Then Argentina defaulted on its debts, and rebounded, astonishingly. Of course, most of blogosphere is looking at Greece in this debate. I am not, because I recognise the Argentinosaurus in the room: America’s foreign-held debt load (payment for all those Nixonian free lunches) is undermining the dollar’s status as global reserve currency, a pattern of development that will ultimately force exporters — on whom America relies — out of exporting to America for worthless sacks of paper and digital. International trade has always been on a quid pro quo basis — and since 1971 that has worked fine for America — dollars have been a necessary prerequisite to acquire oil, other commodities and supplies and pay dollar-denominated debts.

So I think the time has come to explicitly advocate a radical solution to save the dollar — but just as importantly to save the middle classes, and productive capital from the punitive taxation (and welfare cuts) required by austerity.

America needs to balance its budget by gradually (and with negotiation) defaulting on its debts. The first prong of this is totally defaulting on the debt held by the Federal Reserve — this is simply just a circuitous way of cycling money from government to a private agency and back again to the government, while the private agency (the Fed) pays member banks 6% annual no-risk dividends. The second prong is to begin negotiations with international creditors to revalue American debt proportionate to what America can afford to pay in the long run.

Far from infuriating creditors, I think that the evidence shows that this move would benefit everyone. A strong American economy is important to Eurasian producers and exporters. An American-economy dragged down by debt-forced-austerity means a smaller market to sell to, and to gain investment from. The only significant counter-demand for such an arrangement might be a balanced-budget amendment, so that America could no longer borrow more than it can raise in revenues.

Of course, there are other avenues to explore: slashing military spending (and giving the money back to the taxpayer, or to the jobless, or to infrastructure programs) is one such avenue: as I have explained at length before, American military spending is subsidising a flat-market, and making non-American goods artificially competitive in America.

But the real issue today is that liberals mostly want to talk about higher taxes, and conservatives mostly want to talk about austerity. They’re missing the Argentinosaurus in the room: the transfer of wealth from the American public — and the productive American economy — to foreign (and domestic) creditors, and the downward pressure that this is exerting on American output.

Debts — even AAA-rates debt (or AAAAAAAAA as an Oracle once put it) — all carry risk: the risk that the debtor is getting into too much debt and won’t be able to pay back his obligations in a timely or honest fashion. Creditors are making a mistake to be ending money to a fiscal nightmare whose only economic refuge is money printing.

So will America continue to tread the bone-ridden road of austerity, high taxation and crushing economic contraction, leading to excessive money-printing, and ending in the death of the dollar and an inflationary firestorm? Or will it choose the sustainable route of negotiated default, low taxes, a return to productive, organic growth, and the opportunity to decrease reliance on foreign energy and goods?

Romney set himself apart on Friday, arguing that a weaker military and a smaller global footprint will compromise America’s leadership in the world.

“The United States should always retain military supremacy to deter would-be aggressors, and to defend our allies and ourselves,” he said.

Romney said he wants to increase the military budget, mentioning specific projects from naval shipbuilding to a missile defense system. It’s a traditional Republican view of defense that was music to this crowd’s ears.

Romney claims that he wants to cut the debt and cut the deficits and then advocates even greater spending? Gee, that’s just what George W. Bush did:

That huge red spike of debt during George W. Bush’s term? That’s war-spending; Iraq, Afghanistan, and the 865 foreign bases maintained under Bush. That is the spending — not welfare, not medicare, and not infrastructure — that is out of control.

Rome fell through a combination of external overreach, internal corruption, religious transformation, and barbarian invasion. That the United States—and, perhaps even more, the European Union—might have something to learn from his account is too seldom acknowledged, perhaps because Americans and Europeans like to pretend that their polities today are something more exalted than empires. But suppose for a moment (as the Georgetown University historian Charles Kupchan has suggested in The End of the American Era ) that Washington really is the Rome of our time, while Brussels, the headquarters of the European Union, is Byzantium, the city transformed in the fourth century into the second imperial capital, Constantinople. Like the later Roman Empire, the West today has its Western and Eastern halves, though they are separated by the Atlantic rather than the Adriatic. And that is not the only thing we have in common with our Roman predecessors of a millennium and a half ago.

There is a well-established American tradition, perhaps best expressed by Gore Vidal in The Decline and Fall of the American Empire, of worrying that the United States might go the way of Rome. But the perennial liberal fear is of the early Roman predicament more than the late one. It is the fear that the republican institutions of the United States—above all, its hallowed Constitution, based on the careful separation of powers—could be corrupted by the ambitions of an imperial presidency. Every time a commander in chief attempts to increase the power of the executive branch, pleading wartime exigency, there is a predictable chorus of “The Republic is in danger.” We have heard that chorus most recently with respect to the status of prisoners detained without trial at Guantánamo Bay and the use of torture in the interrogation of suspected insurgents in Iraq.

Gibbon could scarcely ignore the question of the Roman republic’s decay. Indeed, there is an important passage in The Decline and Fall that specifically deals with the revival of torture as a tool of tyranny. Few generations of Englishmen were more sensitive than Gibbon’s to the charge that their own ideals of liberty were being subverted by the temptations of empire. The year when his first volume appeared was also the year the American colonies used precisely that charge to justify their own bid for independence.

Yet Gibbon’s real interest lay elsewhere, with the period of Roman decline long after republican virtue had yielded to imperial vice. The Decline and Fall is not concerned with the fall of the republic. It is a story that properly begins with the first signs of imperial overstretch. Until the time of the Emperor Julian (A.D. 331–63), Rome could still confidently send its legions as far as the river Tigris. Yet Julian’s invasion of Mesopotamia (present-day Iraq, but then under Persian rule) proved to be his undoing. According to Gibbon, he had resolved, “by the final conquest of Persia, to chastise the haughty nation which had so long resisted and insulted the majesty of Rome.” Although initially victorious at Ctesiphon (approximately 20 miles southeast of modern Baghdad), Julian was forced by his enemy’s scorched-earth policy to retreat back to Roman territory. “As soon as the flames had subsided which interrupted [his] march,” Gibbon relates, “he beheld the melancholy face of a smoking and naked desert.” The Persians harried his famished legions as they withdrew. In one skirmish, Julian himself was fatally wounded.

What had gone wrong? The answer sheds revealing light on some of the problems the United States currently faces in the same troubled region. A recurrent theme of Gibbon’s work is that the Romans gradually lost “the animating health and vigour” which had made them militarily invincible in the glory days of Julian’s predecessor Trajan. They had lost their discipline. They started complaining about the weight of their armor. In a word, they had gone soft. At the same time, like most armies, their fighting effectiveness diminished the farther they were from home.

Most of us take it for granted that the United States Army is the best in the world. It might be more accurate to say that it is the best equipped and the best fed. More doubtful is how well it is configured to win a protracted low-intensity conflict in a country such as Iraq. One sign of the times that might have amused Gibbon has been the recent relaxation of conditions for recruits undergoing basic training. (A friend of mine who was in the army snorted with derision on hearing that trainees are now allowed eight and a half hours of sleep a night.) Another symptom of military malaise has been the heavy reliance of the Defense Department on National Guard and reserve troops, who have at times accounted for about half of the U.S. contingent deployed in Iraq.

The real problem, however, is a simple matter of numbers. To put it bluntly, the United States has a chronic manpower deficit, which means it cannot put enough boots on the ground to maintain law and order in conquered territory. This is not because it lacks young men; it has at least seven times as many as Iraq. It is that it chooses, for a variety of reasons, to employ only a tiny proportion of its population (half of 1 percent) in its armed forces, and to deploy only a fraction of these in overseas conflict zones.

Rome, like America was a distinctly divided empire in terms of social class, in terms of its economy, in terms of ideology, and in terms of geography. Once, the threat of Soviet dominance kept America strong. But no longer. The culture wars are tearing America apart, and America’s imperial grasp for resources is bankrupting the nation’s treasury. Globalisation has ripped the heart out of American supply chains, manufacturing and its labour force. Financialisation has created classes of greedy parasites, and a hungry and furious class of have-nots. Without global goods and oil, a service economy is fundamentally unsustainable.

And that is what this is about — trying to tighten America’s grip on the things on which the American empire is dependent — oil, and foreign goods. Romney’s play is about trying to sustain the free-lunch economics of Nixon and Kissinger instead of undertaking painful and reforms (i.e. energy independence, reindustrialisation, welfare reform, and demilitarisation) necessary to make America competitive in a multi-polar world.